appraisal practices board (apb) valuation advisories seven (7.0) ce hours

APPRAISAL PRACTICES BOARD (APB) VALUATION ADVISORIES SEVEN (7.0) CE Hours

2 PURPOSE AND DESCRIPTION This seminar is designed to assist real property appraisers in understanding and applying voluntary guidance in recognized valuation methods and techniques as set forth by the Appraisal Practices Board of the Appraisal Foundation. The seminar focuses primarily on advisories directed to real property valuation issues.This seminar is designed to assist real property appraisers in understanding and applying voluntary guidance in recognized valuation methods and techniques as set forth by the Appraisal Practices Board of the Appraisal Foundation. The seminar focuses primarily on advisories directed to real property valuation issues.

3 PURPOSE AND DESCRIPTION (Cont.) The Appraisal Practices Board (APB) was created to complement the work of the Appraisal Standards Board and the Appraiser Qualifications Board. The Uniform Standards of Professional Appraisal Practice requires appraisers to:The Appraisal Practices Board (APB) was created to complement the work of the Appraisal Standards Board and the Appraiser Qualifications Board. The Uniform Standards of Professional Appraisal Practice requires appraisers to: be aware of, understand, and correctly employ those recognized methods and techniques that are necessary to produce a credible appraisal (SR 1-1 (a) and othersbe aware of, understand, and correctly employ those recognized methods and techniques that are necessary to produce a credible appraisal (SR 1-1 (a) and others

4 PURPOSE AND DESCRIPTION (Cont.) The APB was officially formed by The Appraisal Foundation Board of Trustees on July 1, 2010.The APB was officially formed by The Appraisal Foundation Board of Trustees on July 1, 2010. The APB is charged with the responsibility of identifying and issuing opinions on recognized valuation methods and techniques which may apply to all disciplines within the appraisal profession.The APB is charged with the responsibility of identifying and issuing opinions on recognized valuation methods and techniques which may apply to all disciplines within the appraisal profession. The APB offers voluntary guidance in topic areas which appraisers and users of appraisal services feel are the most pressingThe APB offers voluntary guidance in topic areas which appraisers and users of appraisal services feel are the most pressing

5 PURPOSE AND DESCRIPTION (Cont.) The Board utilizes panels of Subject Matter Experts (SMEs), who are widely recognized individuals with expertise in the specific topic being considered, to research and detail all pertinent sources of existing information on the given topic.The Board utilizes panels of Subject Matter Experts (SMEs), who are widely recognized individuals with expertise in the specific topic being considered, to research and detail all pertinent sources of existing information on the given topic. The APB vets the issue through a public exposure process and ultimately adopts guidance that may include more than one recognized method or technique that addresses the specific topic.The APB vets the issue through a public exposure process and ultimately adopts guidance that may include more than one recognized method or technique that addresses the specific topic. From the APB perspective, compliance with all guidance issued by the APB is entirely voluntary.From the APB perspective, compliance with all guidance issued by the APB is entirely voluntary.

6 PURPOSE AND DESCRIPTION (Cont.) The primary sources for this seminar are pertinent USPAP guidelines and requirements, and valuation advisories and exposure drafts from the Appraisal Practices Board, including the following : Real Property Valuation Advisories Adjusting Comparable Sales for Seller ConcessionsAdjusting Comparable Sales for Seller Concessions Residential Appraising in a Declining MarketResidential Appraising in a Declining Market Second Exposure Draft Identifying Comparable PropertiesSecond Exposure Draft Identifying Comparable PropertiesSecond Exposure Draft Identifying Comparable PropertiesSecond Exposure Draft Identifying Comparable Properties Second Exposure Draft Identifying Comparable Properties in Automated Valuation Models and Mass Appraisal ModelsSecond Exposure Draft Identifying Comparable Properties in Automated Valuation Models and Mass Appraisal ModelsSecond Exposure Draft Identifying Comparable Properties in Automated Valuation Models and Mass Appraisal ModelsSecond Exposure Draft Identifying Comparable Properties in Automated Valuation Models and Mass Appraisal Models First Exposure Draft - Valuation of Green Buildings: Background and Core CompetencyFirst Exposure Draft - Valuation of Green Buildings: Background and Core CompetencyFirst Exposure Draft - Valuation of Green Buildings: Background and Core CompetencyFirst Exposure Draft - Valuation of Green Buildings: Background and Core Competency

7 PURPOSE AND DESCRIPTION (Cont.) Current solicitations for APB SMEs Current solicitations for APB SMEs Solicitation for Appraising Newly Constructed Residential PropertiesSolicitation for Appraising Newly Constructed Residential PropertiesSolicitation for Appraising Newly Constructed Residential PropertiesSolicitation for Appraising Newly Constructed Residential Properties Solicitation for Collection and Verification of Sales DataSolicitation for Collection and Verification of Sales DataSolicitation for Collection and Verification of Sales DataSolicitation for Collection and Verification of Sales Data

8 PURPOSE AND DESCRIPTION (Cont.) Business Valuation Advisories Identification of Contributory Assets and Calculation of Economic RentsIdentification of Contributory Assets and Calculation of Economic Rents Discussion Draft - The Measurement and Application of Market Participant Acquisition PremiumDiscussion Draft - The Measurement and Application of Market Participant Acquisition PremiumDiscussion Draft - The Measurement and Application of Market Participant Acquisition PremiumDiscussion Draft - The Measurement and Application of Market Participant Acquisition Premium

9 OBJECTIVES The objectives of the seminar are to provide learners with information and skills that: are transferable to the work environment;are transferable to the work environment; are relevant to increasing earning power;are relevant to increasing earning power; increase awareness and understanding of Appraisal Practices Board voluntary guidance;increase awareness and understanding of Appraisal Practices Board voluntary guidance; increase competence and confidence in applying APB voluntary guidance;increase competence and confidence in applying APB voluntary guidance; provide satisfaction that continuing education money was well spent.provide satisfaction that continuing education money was well spent.

10 OBJECTIVES (Cont.) The seminar will: Assess learner understanding of APB real property valuation advisories;Assess learner understanding of APB real property valuation advisories; Compare and contrast APB advisories to other sources of valuation guidance;Compare and contrast APB advisories to other sources of valuation guidance; Justify the use of strategies for documenting and supporting compliance with APB advisories;Justify the use of strategies for documenting and supporting compliance with APB advisories; Evaluate whether a more in-depth understanding of APB advisories will improve appraiser competence and appraisal quality;Evaluate whether a more in-depth understanding of APB advisories will improve appraiser competence and appraisal quality; Assess personal competency level for applying this knowledge in appraisal assignments.Assess personal competency level for applying this knowledge in appraisal assignments.

11 APB Valuation Advisory #2: Adjusting Comparable Sales For Seller Concessions Date Issued: March 7, 2012 Application: Residential and Non-residential Real Property Issue: As part of its ongoing responsibilities, the APB is tasked with identifying where appraisers and appraisal users believe additional guidance is required. Once such issue identified by the APB is adjusting comparable sales for seller concessions. A common tool used to help facilitate a real property transaction is to have the seller provide financial assistance or incentives to the buyer. Such assistance may be considered a seller concession or financing concession and this is important because it may have an influence on the contract price. The purpose of this guidance is how to identify, verify, analyze and adjust sale comparables for both seller and financing concessions.

12 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions The purpose of this document is to provide additional guidance on generally accepted methods and techniques. The methods and techniques discussed herein may not be the only way to solve this problem as there may be other equally acceptable methods and techniques. The practitioner that uses these other techniques should be able to present and support their use of an alternative technique and support the logic of their analysis. Practitioners that use the guidance contained in this publication must understand and be able to utilize these techniques to provide credible results.

13 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Definitions Sales Concessions A cash or noncash contribution that is provided by the seller or other party to the transaction and reduces the purchasers cost to acquire the real property. A sales concession may include, but is not limited to, the seller paying all or some portion of the purchaser's closing costs (such as prepaid expenses or discount points) or the seller conveying to the purchaser personal property which is typically not conveyed with the real property. Sales concessions do not include fees that a seller is customarily required to pay under state or local laws. In developing an opinion of market value, an appraiser must take into consideration the effect of any sales concessions on the market value of the real property.4 4 2010 Interagency Appraisal and Evaluation and Guidelines, Dec., 2010, P. 44

14 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Definitions Financing Concessions A financial payment, special benefit, or non-realty item included in the sale contract as an incentive to the sale. Concessions occur when the seller agrees to pay an inducement or to give some special credit or property to a buyer who agrees to pay a higher price than the buyer would normally pay in return for the inducement or credit. Concessions usually result in artificially inflated sale prices. Often concessions allow financing that would otherwise not be possible. Concessions may be disclosed as part of the sale, but often they are not. 5 5 Modified from The Dictionary of Real Estate Appraisal, 5th ed. (Chicago: Appraisal Institute, 2010).

15 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Verifying Concessions Appraisers are required by the Uniform Standards of Professional Appraisal Practice (USPAP) to collect, verify and analyze all information necessary for credible assignment results. This is particularly important with regard to sales and financing concessions. The Comment to the definition of Market Value in USPAP states, in part, that the conditions included in market value definitions generally fall into three categories: 1. the relationship, knowledge, and motivation of the parties (i.e., seller and buyer); 2. the terms of sale (e.g., cash, cash equivalent, or other terms); and 3. the conditions of sale (e.g., exposure in a competitive market for a reasonable time prior to sale).6 6 USPAP 2012-13 Edition, Definitions U-4 (The Appraisal Foundation)

16 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Verifying Concessions Since concessions can impact the sale price of a property, an appraiser must identify and analyze the presence of concessions. Public records data rarely report anything other than the actual sale price of a property and do not disclose concessionary items included in the sale. Thus, an appraiser must rely upon other sources to identify and confirm any concessionary items.

17 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Verifying Concessions Sources of information that may be used for verification concessions include, but are not limited to: Listing agent (or sellers agent) Selling agent (or buyers agent) Buyer Seller Lender Title Company Appraisers own records Published data Third party appraisal databases Public Deed Records Other appraisers Tax affidavit

18 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Verifying Concessions Listing agent The listing agent can provide direct knowledge of market activity that is important in understanding whether a sales concession was necessary to entice a buyer to buy, if the price was influenced by the concession, or if the concession was insignificant. Selling/Buyers agent The selling or buyers agent may have knowledge of special buyer motivations; such as any specifics with regard to concessionary items and whether the buyer would have consummated the sale without the concession and any impact the concession may have had on the purchase price.

19 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Verifying Concessions Buyer The buyer can be a source of information about the comparable sale in terms of any sales concessions granted, and how it affected the buying decision. For instance, the buyer can disclose whether they would have paid a different amount for the property were the concession not granted, and whether receiving a concession was the deciding factor for purchasing the property. Seller The seller can identify and confirm concessions and may disclose any impact the concessions had on the sale price, if any. If a property included $5,000 in concessions, an appraiser may question the seller and verify what they would have accepted had they not paid $5,000 in concessions.

20 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Verifying Concessions Closing Department for Real Estate Office, Lender or Title Company The staff in a real estate office, lending institution or title company may provide an appraiser with a settlement or closing statement. The statement will show the itemized costs paid by the seller and those costs paid by the buyer. Concessionary items paid by the seller could be verified in this manner and be invaluable, especially when a party to the transaction will not respond to an appraisers request for information.

21 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Verifying Concessions Appraisers Own Records If an appraiser previously appraised the property they may have information relating to any seller concessions and/or any creative financing. Published Data (e.g. Multiple Listing Services) Providers of published data generally offer basic information regarding sale transactions. However, concessions are not likely to be included in the details of such sales. Reference to this source is thus likely to be a first step in the process, with further investigation needed.

22 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Verifying Concessions Third Party Appraisal Databases and other Appraisers There are some regional and local databases where appraisers submit information about properties they have appraised. These can be sources of verification if these databases are populated with information regarding seller and financing concessions that have personally been verified by a source deemed reliable.

23 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Verifying Concessions Public Deed Records Deed records may be a good verification source if a noted sale price differs from the price reported by published data providers. When there are questions regarding the accuracy of the information that an appraiser has received from one of the parties to the transaction, deeds can provide additional verification. However, in most cases the deed does not reveal concessions, only the transaction amount. Some states are non-disclosure and even the price cannot be verified.

24 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Verifying Concessions Tax Affidavit When a property transfers, most states require the buyer to fill out a true accounting of the cost of the property purchase. These transfer tax affidavits can be useful in determining the true cost of a property and whether the buyer considered a concession to reduce the effective sales price of the property or not. If the buyer considered it a reduction in price, it may be disclosed in this affidavit. Verification of concessions and the impact of concessions on the consideration of a comparable can be done through personal phone calls, text messaging, email or questionnaires and should be documented in the workfile.

25 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Verifying Concessions Examples of what an appraiser may consider: Would the buyer have paid the same amount for the property without the sales or financing concession? What are the details of the reported concession? What impact did the seller/purchaser believe the concession had on the contract price? Was the impact equal to, less than, or more than the actual amount of the concession?

26 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions When Does an Appraiser Adjust For Concessions? If an appraiser identifies and confirms that concessionary items were included in a transaction and if the normal consideration or contract price was impacted by the concession, an appraiser should make an adjustment to approximate the markets reaction to the concessions impact on the comparable sales contract price.

27 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions When Does an Appraiser Adjust For Concessions? If an appraiser identifies and confirms that concessionary items were included in a transaction and if the normal consideration or contract price was impacted by the concession, an appraiser should make an adjustment to approximate the markets reaction to the concessions impact on the comparable sales contract price. Illustration: If an appraiser has determined and verified that the seller paid $5,000 in concessionary items, the appraiser would measure the impact of this concession on the sale price and make an appropriate adjustment to the comparable sales contract price to reflect a price unaffected by the concessions. The adjustment may be more than, less than, or the same amount as the actual dollar amount of the concession.

28 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions When Does an Appraiser Adjust For Concessions? The existence of concessions will be dictated by the type and definition of value used in the appraisal assignment. USPAP defines Value as: the monetary relationship between properties and those who buy, sell, or use those properties.7 7 USPAP 2012-13 Edition, Definitions U-5 (The Appraisal Foundation)

29 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions When Does an Appraiser Adjust For Concessions? According to USPAP, value is an economic concept that is an opinion, based on a specific given time, and must be qualified. In some definitions of value the following conditions are prevalent: Payment will be made in cash in U.S. dollars or in terms of financial arrangements comparable thereto. The price represents the normal consideration for the property sold, unaffected by special or creative financing concessions granted by anyone associated with the sale. The first requirement is the basis for cash equivalency, while the second condition stipulates that the value should reflect a price unaffected by concessions.

30 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions When Does an Appraiser Adjust For Concessions? The Government Sponsored Enterprises (GSEs) included the following additional comment in their definition of market value: *Adjustments to the comparables must be made for special or creative financing or sales concessions. No adjustments are necessary for those costs which are normally paid by sellers as a result of tradition or law in the market area; these costs are readily identifiable since sellers pay these costs on virtually all sales transactions. Special or creative financing adjustments can be made to the comparable property by comparison to financing terms offered by a third party institutional lender that is not already involved in the property or transaction. Any adjustment should not be calculated on a mechanical dollar-for-dollar cost of the financing or concession but the dollar amount of any adjustment should approximate the markets reaction to the financing or concessions based on the appraisers judgment.

31 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions When Does an Appraiser Adjust For Concessions? The above statement: 1. 1.Requires an appraiser to make adjustments for concessions when warranted. 2. Defines which costs to the seller are considered concessionary and which costs would not be considered concessionary. 3. Stipulates that the adjustment for any financing concession should be made to reflect the markets reaction to the financing concession rather than a mechanical dollar-for-dollar cost.

32 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions When Does an Appraiser Adjust For Concessions? In the simplest terms, once an appraiser has identified that a comparable sale sold with a concession, he or she must measure and develop a dollar equivalent of the noted concession, then deduct the dollar amount from the comparables sale price. The net result is a sale price of the comparable which represents the normal consideration for the property sold, unaffected by the concession.

33 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions When Does an Appraiser Adjust For Concessions? In the simplest terms, once an appraiser has identified that a comparable sale sold with a concession, he or she must measure and develop a dollar equivalent of the noted concession, then deduct the dollar amount from the comparables sale price. The net result is a sale price of the comparable which represents the normal consideration for the property sold, unaffected by the concession. An appraiser must be able to recognize and verify what constitutes a seller concession. Costs or fees that are generally paid by a seller as a result of tradition or law and are found on virtually all sale transactions are not considered to be seller concessions. Conversely, other costs or fees paid by the seller would be defined as seller concessions.

34 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions When Does an Appraiser Adjust For Concessions? Fees or costs that are generally paid by the seller as a result of tradition or law and found on virtually all transactions could include, but are not be limited to: sellers title policy, transfer tax, escrow fee, deed preparation, and recording fee. These items are most often thought of as anticipated or expected costs to be paid by the seller. Fees not generally paid by the seller may include, but are not limited to: loan origination fees, appraisal fees, attorney fees, loan application fees, credit report fees, loan document preparation fees, photocopying fees for easements and restrictions, mortgage title policy and loan- related inspection fees, discount fees, etc. For all practical purposes, any fees or costs associated with the buyers loan would generally be considered seller concessions if paid by the seller.

35 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions When Does an Appraiser Adjust For Concessions? The prevalence of seller concessions does not eliminate the need to measure the monetary impact of the concession on the sale price, or negate the need for an adjustment. An appraiser must evaluate the impact of said concessions, regardless of the frequency, prevalence, or how typical concessions may be within a specific market segment or market conditions.

36 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Methodology Special or Creative Financing Special or Creative Financing may include owner carried notes or purchase money mortgages. Concessions will generally fall into two categories: sales concessions and financing concessions. Sales concessions would be the inclusion of personal property, settlement assistance or seller contributions and cash incentives. Financing concessions are special or creative financing and seller discount points or buy-down programs.

37 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Methodology Seller financing may or may not constitute a seller concession, depending on the terms and availability of third-party alternatives. The appraiser should compare the terms of seller financing with those available from traditional lending sources. If the former is more favorable from the borrowers perspective, the present worth of the differential should be quantified. If the latter is more favorable (an unlikely occurrence), there is no seller concession to be considered.

38 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Methodology Illustration A: Dollar-for-dollar (cash equivalent) analysis An appraiser completes a discounted cash flow analysis of seller financing terms based on market financing terms available at the time the contract was negotiated. The present value of the seller-financed mortgage is the sum of two components: 1. The present value of the favorable or below market mortgage payment at the market interest rate for the expected life of the mortgage (10 years Balloon Payment) or the anticipated life of the loan based on the average life of a loan in a particular market; and 2. The present value of the future mortgage balance discounted at the market interest rate for the anticipated life of the mortgage. Assumptions: Sale price was $103,000 with a seller-financed note of $95,000 at 6.0% on a 10-year balloon and 30-year amortization. Market terms at the time the contract was written were 6.5% for 30 years.

39 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions

40 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Given the sale price of $103,000 and market equivalent price of $99,737.44, the impact of the favorable financing on this sale appears to be $3,262.56. Therefore, $99,700 (rounded) would represent the cash equivalent price. This technique is likely to be less reliable than a matched paired sales analysis. To the extent possible, it may be best to simply avoid the use of owner carried notes altogether. This method also may not be as reliable as it does not account for limited closing costs and other fees associated with typical third party financing. Important Note: Although the math suggests a specific dollar amount adjustment, the appraiser should verify with a party to the transaction the impact of the dollar amount; a participant may indicate a dollar amount different than that calculated using the mathematical analysis.

41 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Illustration B: Paired Sales Analysis Two recently sold homes were identical in all aspects, with one exception: Sale 1 sold 10/2010 for $103,000 with seller-financing. The note was for $95,000, amortized over 30 years at 6.0%, with a 10-year balloon. Sale 2 sold 10/2010 for $100,000 on third-party financing. The note was for $95,000, amortized over 30 years with a fixed interest rate at 6.5%.

42 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Given that the two homes are identical in all other aspects, one can measure the impact of the seller financing by comparing the sale prices. The $3,000 difference can logically be attributed to the seller financing. Thus, Sale 1 would require a -$3,000 adjustment. This method accounts for any and all market-perceived effects of the concession: lower interest rate, term, less-than typical closing costs, etc. However, such highly similar comparables may be unavailable for analysis. As such, the appraiser must extract market supported adjustments for any physical differences and adjust the comparables for noted physical differences prior to extraction of any impact the concession may have had on the price.

43 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Illustration C: Paired Sale Analysis Suppose you found three recently sold homes that 212 had the same bedroom-bath count and were of equal age, condition, amenities and lot appeal. The only noted difference would be Gross Living Area (GLA). Sale 1 sold 10/2010 for $103,000 with seller-financing. The note was for $95,000, amortized over 30 years at 6.0%, with a 10-year balloon. This home had GLA of 1500 sf. Sale 2 sold 10/2010 for $104,500 on third-party financing. The note was for $95,000, amortized over 30 years with a fixed interest rate at 6.5%. This home had GLA of 1650 sf. Sale 3 sold 10/2010 for $95,500 on third-party financing. The note was for $90,000, amortized over 30 years with a fixed interest rate at 6.5%. This home had GLA of 1350 sf.

44 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Illustration C: Paired Sale Analysis To determine the impact of the concession (noted on Sale 1) the appraiser may compare Sale 1 to either Sale 2 or Sale 3. However, these two sales differed with regard to GLA as compared to Sale 1. As such, the appraiser must first adjust these sales for GLA. Once, these two sales are adjusted to Sale 1 for size differential, the appraiser will then measure the impact of the noted concession. Step 1; Determine adjustment for GLA Sales 2 and 3 were not impacted by concessions and are nearly identical with exception to size. As such, the appraiser can complete a paired sale of these two sales to extract the adjustment for size. Sale 2 sold for $ 104,500 and was 1650 sf while Sale 3 Sold for $ 95,500 and was 1350 sf. There was a $ 9,000 difference in price and 300 sf difference in size. $ 9,000 divided by 300 sf would indicate that the market supported adjustment for size would be $ 30/sf.

45 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Illustration C: Paired Sale Analysis Step 2: Compare Sale 1 to either Sale 2 or 3. Sale 3 was 150 sf smaller than Sale 1 and sold for $ 95,500. Given the market supported adjustment for GLA of $ 30/sf, Sale 3 would require an adjustment of $ 4,500 and would have an adjusted price $ 100,000. Step 3: Sale 3 has an adjusted price of $ 100,000 and sold on typical third party financing while Sale 1 sold for $ 103,000 on a seller financed note. The $3,000 difference would be attributed to the seller financing, thus the impact of seller concessions was $ 3,000 and the market supported adjustment for this concession would be - $ 3,000.

46 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Seller Paid Loan Discount Points or Buy-Down Programs In some cases, the seller may be asked to pay discount points to buy down the buyers interest rate to qualify for a loan. Discount points are based on a percentage of the mortgage loan and are the dollar amount paid to the lender by the seller to lower the mortgage rate. As the cost of obtaining financing is generally incurred by the buyer rather that seller, it would be considered a concession if the seller pays a fee to buy-down the buyers mortgage rate. The amount of the buy-down is typically sum-certain and established during contract negotiations.

47 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Seller Paid Loan Discount Points or Buy-Down Programs Illustration: An adjustment for seller-paid points is one cash equivalency adjustment that is relatively easy to calculate. The points are applied to the mortgage amount and the result is deducted from the total sale price. For example, consider a comparable property that sold for $130,000. The buyer made a $30,000 cash down payment and financed the balance of the sale price with a $100,000 FHA-insured mortgage. The seller paid the lender 251 three points, which is 3% of the mortgage amount of $100,000 or $3,000. The cash equivalent price of the comparable sale is therefore $127,000 ($100,000 - $3,000 +$ 30,000). 8 Important Note: Although the math suggests a specific dollar amount adjustment, the appraiser should verify with a party to the transaction the impact of the dollar amount; a participant may indicate a dollar amount different than that calculated using the mathematical analysis. 8 Appraising Residential Property, 4th ed.(Chicago); Appraisal Institute, 2007, Page 327-328

48 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Inclusion of Personal Property and Cash Incentives In some market areas the seller will include personal property or other incentives to entice the buyer to purchase the property. Personal property may be in the form of items such as home furnishings, automobiles, boats or golf carts. In an assignment appraising real property only, an appraiser needs to account for personal property and cash incentives included in the sale and adjust accordingly. An appraiser must use caution when estimating the value of personal property. If the appraiser does not have the experience and knowledge to value personal property, he or she may rely on recognized sources, a personal property appraiser, or possibly conversations with parties to the sale. The appraiser may not be able to rely on any values stipulated in the contract as often times this number is minimized to allow for maximum financing. USPAP Standards 7 and 8 provide further guidance on the valuation of personal property.

49 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Inclusion of Personal Property and Cash Incentives Illustration: If 123 Main Street sold for $200,000 and included a golf cart in the sale price, the appraiser would determine the perceived market value of the golf cart from reliable sources. If the appraiser determines the value of said golf cart is ~ $3,500, then the appraiser would make an adjustment of - $3,500 to arrive at an adjusted sale price of $196,500.

50 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Inclusion of Personal Property and Cash Incentives Personal property should be excluded from the contract price of a comparable property; failing to do so would be misleading. Deducting the contributory value of the personal property may require a more complex analysis. The complexity increases for converting non-cash seller concessions such as paid vacations, airline miles, club memberships, and the like into a cash equivalent price. This conversion may require additional interviews with the parties involved in the sale transaction to determine if a monetary value had been agreed upon for the non-cash seller concessions, or if there is an actual dollar value attributed to a specific sale concession such as a golf club membership or a vacation.

51 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Settlement Assistance or Seller Contributions The most common type of seller concession is settlement assistance to the buyer. Settlement assistance exists when the seller pays any fees or costs other than what is generally paid by a seller as a result of tradition or law and are found on virtually all sales transactions. The sellers payment of items such as: loan origination fees, appraisal fees, attorney fees, loan application fees, credit report fees, survey fees, fees for preparation of loan documents, fees for photocopying easements and restrictions, mortgage title policy, loan-related inspection fees, and recording fees, would all be considered concessionary in nature. These fees, when paid by the seller, are considered to be concessionary in nature if they are not paid by the seller as a result of convention or law on virtually all sale transactions.

52 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Settlement Assistance or Seller Contributions Settlement assistance is similar to loan discount points paid by the seller as it is a sum-certain amount generally agreed upon during contract negotiations. It is reasonable to conclude that payment of this type concession or lack thereof would have been a deciding factor and most likely impacted the price the seller was willing to accept. As such, the impact of said concession may be at least equal to the actual dollar amount of the concession. To determine the impact of settlement assistance on the contract price of a comparable sale, the appraiser may rely on deductive reasoning (along with the appropriate verification) or an interview with one of the agents or other parties to the sale.

53 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Settlement Assistance or Seller Contributions Illustration: When verifying a transaction with the selling agent an appraiser is informed that the seller paid $5,000 of the buyers closing costs or settlement fees. The home sold for a contract price of $155,000. The agent indicated that if the seller had not been asked to pay $5,000 in concessions, he/she would have accepted an offer of $150,000. As such, an appropriate adjustment would be $5,000. Deductive reasoning (along with the appropriate verification) would also suggest that this may be a reasonable and supportable conclusion.

54 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Statistical Analysis Statistical tools may be employed to support adjustments for seller concessions. Because of the number of independent variables required for analysis of both residential and non-residential properties, the most useful statistical tool is multiple linear regression. The number of variables requires the utilization of an adequate sample size of transactions with and without seller concessions. The fact that concessions may take several forms complicates the regression modeling process. Nonetheless, multiple linear regression may be a valuable analytical tool in quantifying and supporting adjustments for seller concessions. The appraiser should have adequate knowledge of, and experience in, statistical methodology (including appropriate sample size) in order to competently utilize such tools. The following are source materials that may be useful to the appraiser in statistical analysis: (See page 12 of APB Valuation Advisory #2 )

55 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Concessions and Non-residential Property (other than 1-4 unit properties) If concessions are present, the appraiser would use the same methodology as with residential property. However, given that non-residential property is usually significantly differentiated in terms of physical and economic characteristics (e.g., lease and occupancy rates, lease terms and expiration dates, etc) the results may be less reliable. (See pages 13-15 of APB Valuation Advisory #2)

56 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Impact and Application of Concessions in the Cost Approach and Income Approach Cost Approach - Concessions may impact this approach in the following situations: If the land residual technique, abstraction method or the allocation method is used to support site value, comparable sales with seller concessions should be adjusted for any impact said concession had on the sale price prior to application of this technique. When using market extraction to determine Reproduction Cost New (RCN) an appraiser would need to adjust the sale price of any comparable that sold with seller concessions prior to the analysis. If depreciation estimates are derived by use of comparables with seller concessions, the appraiser would need to adjust sales for any impact said concession had on the sale price prior to depreciation analysis.

57 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Impact and Application of Concessions in the Cost Approach and Income Approach Income Approach - Concessions may impact this approach in the following situations: Capitalization Rate (Ro) Development of a Cap Rate by extraction from comparable sales with seller concessions may be misleading unless the appraiser measures and deducts the impact of said concession from the sale price. The appraiser should deduct the impact of any concessions on the sale price prior to determining an appropriate capitalization rate. Gross Rent Multiplier (GRM) or Gross Income Multiplier (GIM) Development of GRM and GIM by extraction from comparable sales with seller concessions may be misleading unless the appraiser measures and deducts the impact of said concession from the sale price. The appraiser should deduct the impact of any concessions on the sale price prior to determining an appropriate GRM or GIM.

58 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Impact and Application of Concessions in the Cost Approach and Income Approach Income Approach (Cont) Master Leases/Rent Guarantees It is not uncommon for sellers of unstabilized properties to guarantee the purchaser a specified minimum income for a fixed period, in order to achieve a price reflective of stabilization. A portion of the sale price is placed in escrow and is reimbursed to the buyer if the agreed-upon level of revenue is not achieved during the master lease term. While the sale prices of such transactions may arguably be reflective of an as stabilized price, it is clear that the price is not that for the property on an as is basis, as of the date of sale. The most supportable adjustment in such instances is based upon the quantified impact of the master lease as reported by buyer and seller. If such information is not available, the adjustment may be reasonably based upon the present worth of the revenue shortfall during the term of the master lease.

59 APB Valuation Advisory #2:(Cont.) Adjusting Comparable Sales For Seller Concessions Suggested Further Reading (See APB Valuation Advisory #2, page 17)

60 APB Valuation Advisory #3: Residential Appraising in a Declining Market\ Executive Summary Many appraisers and users of appraisal services have raised important questions regarding appraisals prepared in declining markets. Some of the questions that have been asked include: I. How should an appraiser define a declining market? What has to happen in a market for an appraiser to designate it declining? Defining a declining market is difficult. Many appraisers and users of appraisal services differ on what constitutes a declining market. This document suggests that it is incumbent on the appraiser to develop the definition of a declining market or obtain a supportable definition from a legitimate source, preferably not the client. Regardless of how the definition is obtained the appraiser should state and illustrate what the term declining market means in the context of the appraisal report. Credibility is added by citing the evidence upon which the conclusion is based.

61 APB Valuation Advisory #3: Residential Appraising in a Declining Market What databases or publications are available to help an appraiser support an opinion of market trends? Many appraisers find it difficult to support their opinions of market trends because of lack of retrievable and verifiable market data; often the quantity of comparable sales does not support statistical analysis. National, regional or local databases can be used to support evidence of market trends. [BLC Note: The New Jersey Association of Realtors announced in the October 2013 Edition on New Jersey Realtor that they will be providing state-wide, county, and municipal market data on a monthly basis. Go to njar.com/10K or visit NJARs YouTube channel at youtube.com/realstoryNJ.]

62 APB Valuation Advisory #3: Residential Appraising in a Declining Market Databases While the types of databases listed in this document are used by many appraisers, others are available and may be equally or more relevant to appraisers work. Some residential databases can present sophisticated analysis as part of their programs. The appraiser must be careful to read the background information of any database considered to at least understand about possible biases and if the bias is too great, to eliminate the data. Users of secondary data must understand the process of collecting and analyzing the data to ensure the use of the information is applicable in an appraisal. This means appraisers are responsible for knowing the source, applicability, and reasonableness of the data and analysis prepared by others that is presented in their appraisal reports. Most clients do not ask residential appraisers to perform significantly detailed market analyses (scope of work). However, clients are asking appraisers to indicate if markets are declining, increasing or stable. Support for such conclusions can be accomplished with numerous methods. Section II is not intended to eliminate other valid tools used by appraisers but does suggest that any other tools utilized be tested against other methodologies to ensure their validity.

63 APB Valuation Advisory #3: Residential Appraising in a Declining Market If a client instructs an appraiser to include, or exclude, data from short sales or REO comparables, does that comply with the definition of value in the report? Besides market value, what other defined values could an appraiser use? Clients can stipulate conditions on appraisal development but even if asked, appraisers cannot develop or report misleading analyses, opinions, or conclusions. Other value terms that are used in practice include: Disposition value Liquidation value Other client-defined terms including durable value and foreclosure value Clients can stipulate conditions on appraisal development but they cannot ask an appraiser to develop and report a misleading analysis or assignment results. If the client stipulates the inclusion or not of a particular type of comparable, the appraiser may have to revisit, with the client, the type of value developed.

64 APB Valuation Advisory #3: Residential Appraising in a Declining Market When labeling a market as declining, should the appraiser limit the criteria to an area equal to the neighborhood, or should a market study include a larger or smaller geographical area? A neighborhood is a grouping of complementary land uses. This is a geographically defined term and therefore could include residential, commercial and even industrial uses within the neighborhood. A market study is focused on competing properties; therefore a market analysis need not have the same geographic limits as the neighborhood. When defining a market it is important to use parameters that include competing properties and exclude noncompetitive properties. The market area may be more important than the neighborhood.

65 APB Valuation Advisory #3: Residential Appraising in a Declining Market Is it an appraisers responsibility to verify data used in an appraisal? Should an appraiser know what the primary motivations were of the buyers of each comparable? If an appraiser is developing an opinion of market value it is necessary to decide who the most likely type of buyer would be. In some markets, the most likely buyer is an investor who requires an entrepreneurial incentive and in other markets the most likely buyer is an owner/user who decides what property to purchase based on his or her specific needs. Determining the most likely type of buyer requires data verification, which is also required by USPAP. The intended use of the appraisal, based on communication with the client, influences the type and definition of value to be used in the assignment, which in turn guides the selection of comparable transactions.

66 APB Valuation Advisory #3: Residential Appraising in a Declining Market In declining markets where appraisers need to adjust for differences in buyer motivations, may an appraiser make condition-of-sale adjustments? What are reasonable methods for supporting adjustments in declining markets for conditions of sale? Appraisers can use condition-of-sale adjustments to compensate for the motivations of the participants in the sale. If the most likely buyer is an investor, it may be necessary to adjust for the required entrepreneurial incentive. When using secondary market appraisal forms the appraiser should account for conditions of sale (although this applies in any market, not just those that are declining).

67 APB Valuation Advisory #3: Residential Appraising in a Declining Market Four generally-accepted techniques may be utilized to support adjustments in appraisals. These techniques include the following: Extraction from comparable sales also known as paired sales analysis. Depreciated cost Cost of construction less all applicable depreciation. Income capitalization If rental differences reflect the market adjustments. Buyer interviews If truthful answers can be obtained, this technique most clearly mirrors market reaction to a feature or an arrangement. In declining markets, the most commonly-used technique for supporting condition-of-sale adjustments is extraction from comparable sales. This is often done by paired-sales analysis.

68 APB Valuation Advisory #3: Residential Appraising in a Declining Market Integration of the Opinion of Market Trends into the Appraisal Analysis In many appraisal analyses, the only need for adjustment for declining markets is in the cost approach (in the form of external obsolescence). In most circumstances, an appraiser that uses comparable sales from the same market as the subject should already reflect market conditions. The income approach should already reflect a weak market because of lower rental rates and lower gross rent multipliers..

69 APB Valuation Advisory #3: Residential Appraising in a Declining Market In declining markets, what statistical tools are available to support adjustments and rates of change in market conditions? More and more statistical tools are becoming available to appraisers and valuation companies. While development of Automated Valuation Models (AVM) or Computer Assisted Mass- Appraisal (CAMA) may be most closely associated with large firms with considerable assets, current technology and databases allow appraiser-practitioners to access and develop their own statistical tools to support opinions about market trends..

70 APB Valuation Advisory #3: Residential Appraising in a Declining Market In conclusion, when appraising during a period of declining markets: 1.It is incumbent on the appraiser to develop or adopt a supported definition for a declining market, and to support a conclusion of that decline in his or her appraisal; 2. Several sources of data are available to support conclusions of declining values; 3. In addition to market value, numerous definitions of value exist; one or more of these other definitions may better describe the nature of competitive transactions in the relevant marketplace and meet the clients needs; 4. The market area may be more relevant for the collection and analysis of trend data;

71 APB Valuation Advisory #3: Residential Appraising in a Declining Market 5. Verification with one or more of the parties to the transaction will be needed to understand the motivations of market participants and to enable forming a conclusion of the likely buyer type as a subset of the highest and best use conclusion; this in turn influences the selection of the value definition (in conjunction with communication with the client), which in turn guides the selection of comparable transactions; 6. Supported adjustments should be made where necessary for condition- of-sale adjustments in declining markets; and 7. Statistical methods may offer a way to support a variety of adjustments. [End of Executive Summary]

72 APB Valuation Advisory #3: Residential Appraising in a Declining Market I. How Should an Appraiser Define a Declining Market? (Page 24) II. What Databases are Available to Support a Market Trend Conclusion? (Page 26) III. What are Some Alternative Value Definitions? (Page 27) IV. Defining a Market vs. a Neighborhood (Page 30) V. Verification of Data (Page 32) VI. Support for Adjustments (Page 35) VII. Integration of the Opinion of Market Trends into the Appraisal Analysis (Page 37) VIII. Using Statistical Tools in the Development of Appraisal Analysis (Page 37) Glossary of Terms (Page 41) Bibliography and Other Readings on the Subject (Page 49)

73 Revised APB Valuation Advisory #4 Identifying Comparable Properties Important Note: This revised APB Advisory #4 is being issued to make edits to a Supreme Court Case citation on page 9 for the Mississippi & Rum River Boom Co. v. Patterson, 98 U. S. 403 (1878). Additional edits were made to add complete text titles and correct page references in the Glossary of Terms and Definitions beginning on page 13. Date Issued: September 26, 2013 Application: Residential and Non-residential Real Property

74 Revised APB Valuation Advisory #4 Identifying Comparable Properties Comparability analysis is a fundamental study in determining property value. This analysis involves a side-by-side examination of physical and transaction characteristics of the identified comparable properties relative to the subject. The reliability of this valuation technique relies heavily on the proper selection of suitable comparable properties. This guidance discusses the terms and definitions associated with a comparable property, the characteristics generally considered for determining comparability; and the degree of suitability of a property as a comparable. The guidance addresses whether there is a threshold of differences, which based on their magnitude, automatically disqualifies a property as comparable. The guidance examines a closely related topic; the differences between the terms, market area and neighborhood and a broad summary of the characteristics to consider for delineating a market area.

75 Revised APB Valuation Advisory #4 Identifying Comparable Properties I. Introduction Real property valuation considers three approaches to value which are distinctly different given their underlying foundational premises. However, all three approaches rely on a comparability analysis in developing credible results under each approach. The Sales Comparison Approach provides an indication of value based on units of comparison derived from sales of similar or comparable properties. The Cost Approach requires land value comparability analysis, cost comparability analysis, and market extracted depreciation comparability. The Income Approach requires income/lease comparability, expense comparability, income potential comparability, capitalization rate, and minimum acceptable rate of return on investment comparability. All of the above approaches rely on the same fundamental underpinnings of determining comparability. Therefore the identification of what constitutes a similar, or comparable property is critical to the proper application of the three approaches to value. In this Advisory we will provide guidance to assist in the identification of comparable properties.

76 Revised APB Valuation Advisory #4 Identifying Comparable Properties II. Property Characteristics The principle of substitution is the foundation of comparability. It states that a rational buyer will not pay more for an item than the cost of an acceptable substitute. The appraiser must analyze transactions of closed sales, pending sales, and listings of properties and determine which are acceptable substitutes by weighing the elements of comparison. In developing an opinion of value for the subject property, the appraiser attempts to answer the question What would a buyer of the comparable property have paid for the subject property given the observed sale price (or asking price, in the case of a listing) for the comparable property? Generally speaking, the more similar a competing property is to the subject property, the better. A high degree of similarity in property characteristics between the subject property and the available properties improves comparability. Many courts recognize ...that similar does not mean identical, but means having a resemblance, and that property may be similar in the sense in which the word is here used though each possesses various points of difference. 2

77 Revised APB Valuation Advisory #4 Identifying Comparable Properties II. Property Characteristics The appraiser weighs the relevance of the property characteristics (including, but not limited to: location, economic, legal and physical factors) based on the importance assigned by market participants. The most relevant property characteristic(s) are then examined on each available property. By examining and weighing the relevant property characteristics, the appraiser is better prepared to select the most appropriate comparable properties available. Another court has defined a comparable property as one that Has similar use, function, and utility; is influenced by the same set of economic trends and physical, governmental, and social factors; and has the potential of a similar highest and best use. 3 3 Montana Code Annotated 2011, 15-1-101, retrieved from http://data.opi.mt..gov/bills/mca/15/1/15 1 101.htm on 08/26/2012.

78 Revised APB Valuation Advisory #4 Identifying Comparable Properties II. Property Characteristics Because real property is truly unique, there are always differences between the property under analysis and the selected competing properties used for comparative purposes. When considering a property as a comparable, the appraiser should first ask Is the property sufficiently similar, in all fundamental aspects to the subject property? This leads to the critical analysis of evaluating the property characteristics that make a property sufficiently similar. The following chart below summarizes the primary elements of comparison: (Page 55)

79 Revised APB Valuation Advisory #4 Identifying Comparable Properties

80 Revised APB Valuation Advisory #4 Identifying Comparable Properties III. Comparable Suitability Sales information4: Before a property can be considered a comparable, the appraiser must confirm the type of sale transaction. In other words, did the sale occur under conditions commensurate with the type and definition of value under consideration? In the case of market value, the following factors must be considered: 4 Sources of sales information are discussed in APB Valuation Advisory #2: Adjusting Comparable Sales For Seller Concessions.

81 Revised APB Valuation Advisory #4 Identifying Comparable Properties III. Comparable Suitability (Cont.) 1. Did the sale convey property rights similar to the property rights being appraised? Were the property rights similarly encumbered or unencumbered at the time of sale? 2. Were both the buyer and seller typically-motivated? 3. Were both parties well informed or advised and each acting in what they considered their own best interests? 4. Was the property allowed exposure in the open market for a reasonable length of time? 5. Was payment made in cash or its equivalent? 6. Was financing, if any, on terms generally available in the community at the time of sale and typical for the property type in its locale? 7. Did the price represent normal consideration for the property sold unaffected by special financing amounts and/or terms, services, fees, costs, or other credits incurred in the transaction? 5 5 Real Estate Valuation in Litigation, 2nd Edition, pp. 204-205.

82 Revised APB Valuation Advisory #4 Identifying Comparable Properties III. Comparable Suitability (Cont.) The appraisers experience and skill in consistently observing the market coupled with ongoing interviews with buyers, sellers, and brokers as to what factors drive local values assist in providing credible value indications by comparison. In addition to closed sales, knowledge of listings and pending (under contract) properties may be used to demonstrate the most current market activity and current competition considered by potential buyers. Because the final conveyance amount is unknown, listing comparables and pending sales should be used cautiously, but are often helpful: (a) in establishing the upper limit of probable value in the final reconciliation, or (b) as guidance in times of rapidly changing market conditions.

83 Revised APB Valuation Advisory #4 Identifying Comparable Properties III. Comparable Suitability (Cont.) The appraiser cannot control the quality or suitability of the activity available in the market during the timeframe of analysis. Information could be limited in many markets, and many properties do not lend themselves to simplified comparison. In such cases, analysis of older transactions may also be required due to limited current activity in the market; however, such data should be cautiously considered. It is necessary for the appraiser to clearly express these limitations and to reconcile the reliability of the approach where a substantial number of the elements are sufficiently different.

84 Revised APB Valuation Advisory #4 Identifying Comparable Properties III. Comparable Suitability (Cont.) Magnitude of adjustments: In markets where competing properties are highly similar to the subject property, it is unlikely that large and/or numerous adjustments would be required. However, in markets that are less homogeneous or have limited market activity, it is possible that large and/or numerous adjustments may be necessary. When a comparative analysis requires large and/or numerous adjustments, questions may arise regarding the true comparability of the property. At what point is a competing property not considered comparable? While there is no single source to determine comparability, it is up to the appraiser within the context of the scope of work to determine whether the property is comparable and will lead to credible assignment resultsThe degree of similarity varies from case-to-case, so neither appraisers nor the courts can arrive at a formula to test comparability or similarity.

85 Revised APB Valuation Advisory #4 Identifying Comparable Properties III. Comparable Suitability (Cont.) Some of the most common written guidelines on this issue are the appraisal underwriting guidelines issued by Government Sponsored Enterprises (GSE) (e.g., Fannie Mae). It is important to recognize that these appraisal guidelines are written primarily to determine whether or not a property is eligible for purchase on the secondary mortgage market, and not as a definitive tool to determine comparability. GSE guidelines also apply exclusively to residential properties, generally speaking the most homogeneous property class nationally with sufficiently similar properties transacting within the shortest period of time. It is typical to find that appraisals of non-residential properties, complex residential properties, and properties in unstable markets require the use of comparable properties that may possess greater differences.

86 Revised APB Valuation Advisory #4 Identifying Comparable Properties III. Comparable Suitability (Cont.) According to Fannie Mae, a property is comparable if the market considers it a competitive substitute. Once a property is determined to be comparable by the appraiser, then appropriate analysis and market adjustments are applied. Analysis and adjustments to comparable sales must be based on market data for the particular neighborhood and for competing locations not on predetermined or assumed dollar adjustments. Adjustments must be made without regard for the percentage or amount of the dollar adjustments.7 (Bold added for emphasis.) The key is for the appraiser to adequately explain and support the rationale for using the comparable properties selected in the appraisal report. Such narrative assists in demonstrating the reliability and credibility of the opinion of value. Where the comparable properties possess significant differences from the subject property, additional comparable properties may be included for additional support of the opinion of value.

87 Revised APB Valuation Advisory #4 Identifying Comparable Properties III. Comparable Suitability (Cont.) Appropriate analysis, consideration, and explanations are necessary regardless of the amount of an adjustment. If numerous adjustments or a singular atypical adjustment is required, then an explanation and support (i.e., stating search criteria and results) regarding the lack of more similar properties that require fewer adjustments should be explained. If the subject property has a significant element of comparison that competing properties lack or conversely, if the subject property lacks a significant element of comparison that competing properties possess, explanation is necessary. In such situations, generally recognized appraisal methodology would dictate an effort to use comparable properties that are both superior and inferior to the subject for that specific element of comparison (this process is often referred to as bracketing). Comparing properties with superior, similar, and inferior elements of comparison to the subject property may assist in validating the adjustments applied.

88 Revised APB Valuation Advisory #4 Identifying Comparable Properties III. Comparable Suitability (Cont.) Following is an illustration of bracketing on two physical features of a residential subject property. The features bracketed in this illustration are the subject propertys gross living area above grade and the garage count. This is a generalized illustration of the sales comparison analysis focusing on these two units of comparison only (highlighted in yellow). In the following example, the subject propertys gross living area (GLA) was measured at 2,200 sq. ft. The GLA feature is bracketed by comparable property # 1 that has an inferior GLA at 1,950 sq. ft. and by comparable property # 2 that has a superior GLA at 2,500 sq. ft. Similarly, the subjects 1-car garage amenity is bracketed by comparable property # 1 that has a superior garage count of 2-cars and by comparable property # 2 that has an inferior garage amenity of no garage.

89 Revised APB Valuation Advisory #4 Identifying Comparable Properties III. Comparable Suitability (Cont.)

90 Revised APB Valuation Advisory #4 Identifying Comparable Properties III. Comparable Suitability (Cont.) In this illustration, the subjects sale price of $183,000 is also bracketed by the pre-adjusted sales prices of the comparable properties ($180,000 to $185,000). Both downward and upward adjustments are applied resulting in the adjusted sale price range of $183,000 to $184,500 (the value bracket of probable range) for the subject property. When a sales comparison approach requires substantial and varied adjustments, the reconciliation should enable the reader to understand why the sales were used. Adequate reconciliation is a required and integral part of any value conclusion. Standards Rule 1-6(a) of the Uniform Standards of Professional Appraisal Practice8 states: In developing a real property appraisal, an appraiser must reconcile the quality and quantity of data available and analyzed within the approaches used. 9

91 Revised APB Valuation Advisory #4 Identifying Comparable Properties III. Comparable Suitability (Cont.) Highest and Best Use: A necessary consideration for determining if a property is comparable is whether the highest and best use of the subject property and the competing property is the same. Appraisers have a special responsibility to scrutinize the comparability of all data used in a valuation assignment. They must fully understand the concept of comparability and should avoid comparing properties with different highest and best uses, limiting their search for comparables, or selecting inappropriate factors for comparison. 10 Likewise, the Supreme Court of the Unites States in Mississippi & Rum River Boom Co. v. Patterson, 98 U.S. 403 (1878), states that the highest and best use of a property should consider a change in current use of a property by reference to the uses for which the property is suitable, having regard to the existing business or wants of the community, or such as may be reasonably expected in the immediate future. These factors can be applied to both the subject property and the selection of comparable properties.

92 Revised APB Valuation Advisory #4 Identifying Comparable Properties IV. Market Area and Neighborhood Characteristics Location is a primary consideration in the comparable property selection process. Ideally, a comparable property would compete with the subject property in location as well as other characteristics. When considering a comparable propertys location competitiveness to the subject property, the subject propertys local market performance and characteristics are measured alongside the comparable propertys local market. Preferably, the comparable property is located in the subject propertys market area. While the terms market area and neighborhood are often used interchangeably, in truth, the two terms have distinctly different meanings, in both residential and non-residential appraising. Data and analysis related to a neighborhood is broad and general in nature, whereas data and analysis related to a market area is specific and related to a particular property type or category. 11 The confusion between these two concepts arises in practice because the method of delineation for both a market area and a neighborhood follow the same four basic principles. Both can be defined by their physical boundaries (man-made and natural) and their intangible boundaries social and political).

93 Revised APB Valuation Advisory #4 Identifying Comparable Properties IV. Market Area and Neighborhood Characteristics Appraisers make a distinction between the neighborhood in which a property is situated and the market area in which comparable properties will be found are located. Market area is formally defined as the geographic or location delineation of the market for a specific category of real estate, i.e., the area in which alternative, similar properties effectively compete with the subject property in the minds of probable, potential purchasers and users. In contrast, a neighborhood is defined more generally as a group of complementary land uses. 12 In other words, the neighborhood boundaries in which the subject property is located may contain residential properties as well as non-residential properties that serve the residents of the neighborhood, whereas the boundaries of the market area for the subject property is based on the area in which similar properties compete with one another. In some cases, the subject propertys neighborhood and market area may have the same boundaries, but in other cases the market area may contain several neighborhoods or portions of different neighborhoods. A market area is defined by the type of property, the type of transaction (rental or sale), the geographic area in which competition exists, and the homogeneity of properties within its boundaries. 13

94 Revised APB Valuation Advisory #4 Identifying Comparable Properties IV. Market Area and Neighborhood Characteristics The geographic area used for selecting comparable properties depends on the property type. For a large industrial property, regional or national market areas may be relevant since this is the market in which buyers of similar properties effectively compete. For a (non-complex) residential property, adequate sales data may be available within a few blocks of the subject property.14 Neighborhoods tend to define the primary market area for most non-complex residential properties since homes in the area immediately surrounding a property tend to attract like-minded buyers. However, it is recognized that competitive neighborhoods within a larger market area might need to be considered. Care should be taken to analyze and align the specific neighborhood characteristics to ensure they are truly competitive. Note: Market discussion for non-residential properties starts on page 61.

95 Revised APB Valuation Advisory #4 Identifying Comparable Properties V. Summary of Valuation Advisory #4 starts on page 62 VI. Glossary of Terms and Definitions starts on page 63 APPENDIX I: Examples of Physical Comparability Factors starts on page 66 APPENDIX II: Suggested Further Reading starts on page 67

96 Draft White Paper Alternative Valuation Products and the Uniform Standards of Professional Appraisal Practice TO: All Interested Parties FROM: John S. Brenan Director of Appraisal Issues RE: Draft White Paper Alternative Valuation Products and the Uniform Standards of Professional Appraisal Practice DATE: October 8, 2013

97 Draft White Paper Alternative Valuation Products and the Uniform Standards of Professional Appraisal Practice At the request of its Industry Advisory Council, The Appraisal Foundation has drafted the attached white paper on Alternative Valuation Products and the Uniform Standards of Professional Appraisal Practice (USPAP). The white paper is intended to provide information to assist appraisers, users of appraisal services, and others, with a greater understanding of Alternative Valuation Products and their use in the marketplace. The paper also attempts to view these products in light of an appraisers USPAP obligations. All interested parties are encouraged to comment in writing before the deadline of December 31, 2013. Respondents should be assured that each comment will be thoroughly read and considered.

98 Draft White Paper Alternative Valuation Products and the Uniform Standards of Professional Appraisal Practice Written comments on this white paper can be submitted by mail, email and facsimile. Mail: Comments: Alternative Valuation Products and the Uniform Standards of Professional Appraisal Practice (USPAP) The Appraisal Foundation 1155 15th Street, NW, Suite 1111 Washington, DC 20005 Email: [email protected] Facsimile: (202) 347-7727

99 Draft White Paper Alternative Valuation Products and the Uniform Standards of Professional Appraisal Practice IMPORTANT NOTE: All written comments will be posted for public viewing, exactly as submitted, on the website of The Appraisal Foundation. Names may be redacted upon request. The Appraisal Foundation reserves the right not to post written comments that contain offensive or inappropriate statements. If you have any questions regarding the attached exposure draft, please contact John S. Brenan, Director of Appraisal Issues at The Appraisal Foundation, via e-mail at [email protected] or by calling (202) 624-3044.

100 Draft White Paper Alternative Valuation Products and the Uniform Standards of Professional Appraisal Practice Introduction In the appraisal industry, particularly the residential mortgage sector,1 there has been a proliferation of products and processes attempting to provide alternatives to traditional appraisals in recent years. The primary factors behind development of these Alternative Valuation Products (AVPs) are generally to reduce cost and improve timeliness. For many years appraisers heard tales of someday being replaced by a black box that could determine the value of a property without the judgment that an appraiser may bring. In fact, to some extent this has come to pass with products that exist and are in use today, such as Automated Valuation Models (AVMs). Interestingly, however, there are many cases where an appraisers training, experience and expertise are necessary to provide a credible analysis and, ultimately, opinion of value.

101 Draft White Paper Alternative Valuation Products and the Uniform Standards of Professional Appraisal Practice This paper will attempt to: identify a number of the products being used today as alternatives to an appraisal; describe who uses these alternative products and why14 discuss who performs assignments utilizing alternative products; and examine these 15 products in light of the Uniform Standards of Professional Appraisal Practice (USPAP). While this document is neither intended to be an exhaustive study of all AVPs, nor a thorough examination of their overall impact in the collateral valuation marketplace, it is hoped that this paper can be an aid to understanding AVPs and why they are being used. It is our belief that a USPAP-compliant appraisal completed by a competent and ethical appraiser remains the gold standard, incorporating relevant data and the analytical expertise provided by an appraiser. However, we fully recognize that AVPs play an important role in the valuation marketplace, and we would be remiss not to examine that role in a meaningful manner.

102 Draft White Paper Alternative Valuation Products and the Uniform Standards of Professional Appraisal Practice What is an Alternative Valuation Product (AVP)? For purposes of this paper, we will define an Alternative Valuation Product (AVP) as: A product that communicates an opinion of value (or price) other than a traditional appraisal. Note: In the residential mortgage valuation sector, this means something other than an appraisal developed and reported using standard Fannie Mae/Freddie Mac appraisal report forms. It should be noted that not everyone in the residential mortgage sector defines an AVP as noted above. However, this is the definition that we will base this paper on and AVPs will be viewed in comparison to appraisal reports prepared using standard Fannie Mae/Freddie Mac appraisal report forms.

103 Draft White Paper Alternative Valuation Products and the Uniform Standards of Professional Appraisal Practice As indicated in the preceding paragraph, AVPs may offer opinions of value or price. Although some clients may not distinguish between these terms, it is worthwhile to note that USPAP does. USPAP2 defines the terms as follows: VALUE: the monetary relationship between properties and those who buy, sell, or use those properties. Comment: Value expresses an economic concept. As such, it is never a fact but always an opinion of the worth of a property at a given time in accordance with a specific definition of value. In appraisal practice, value must always be qualified - for example, market value, liquidation value, or investment value. PRICE: the amount asked, offered, or paid for a property. Comment: Once stated, price is a fact, whether it is publicly disclosed or retained in private. Because of the financial capabilities, motivations, or special interests of a given buyer or seller, the price paid for a property may or may not have any relation to the value that might be ascribed to that property by others. As indicated by the definitions above, USPAP does not provide for an opinion of price, since it defines price as a fact.

104 Draft White Paper Alternative Valuation Products and the Uniform Standards of Professional Appraisal Practice What are some common examples of AVPs? There are a number of AVPs in the marketplace, with the number seeming to increase frequently. The list below is not intended to be exhaustive in nature; rather it is illustrative of some common AVPs in use today, along with a brief description of each.

105 Draft White Paper Alternative Valuation Products and the Uniform Standards of Professional Appraisal Practice Broker Price Opinions (BPOs) One of the most commonly- recognized AVPs, BPOs have been used for many years by real estate brokers in the ordinary course of their real estate brokerage businesses. The product was originally designed to assist homebuyers and sellers in real estate listing and sale transactions, but in recent years its use has been expanded for additional purposes. There is no single recognized BPO form or format; many have been developed over the years and tweaked for the users specific needs. The sample BPO form included in this document (see Appendix) was developed by Freddie Mac for loan servicing purposes. [Example of a Brokers Price Opinion (BPO) Page 87]

106 Draft White Paper Alternative Valuation Products and the Uniform Standards of Professional Appraisal Practice Comparative Market Analysis (CMAs) A CMA is a product which originally was used in a very similar fashion to BPOs, but could also be used by agents (i.e., real estate salespeople). Like BPOs, in addition to closed sales CMAs may also use pending sales and active listings to assist homebuyers and sellers. There is also no single CMA form or format that is universally utilized. [See sample page 89]

107 Draft White Paper Alternative Valuation Products and the Uniform Standards of Professional Appraisal Practice Automated Valuation Models (AVMs) In a sense AVMs are, in fact, the black boxes some appraisers feared for many years. AVMs utilize a great deal of data and mathematical formulae to calculate estimates (or opinions) of value. Although some appraisers retain negative feelings towards AVMs, these products have proven to have a place in the valuation marketplace. The downside of AVMs is that they are completely reliant on available data, which might require the type of filtering performed by an appraiser. One variation of an AVM is known as an Appraiser assisted AVM, which is intended to lend an appraisers expertise to the value calculated by an AVM.

108 Draft White Paper Alternative Valuation Products and the Uniform Standards of Professional Appraisal Practice II. What types of clients order AVPs ? To better understand what types of clients use AVPs, it may be best to first identify those clients and transactions where AVPs are not allowed. Under Title XI of FIRREA, all federally-related transactions 3 and real estate-related transactions 4 require a USPAP compliant appraisal, performed by a state-licensed or state-certified appraiser. In these cases, the use of an AVP is not permitted as the basis for collateral evaluation. It is also important to recognize that the federal financial regulatory agencies publish guidelines for appraisals, as well as what they refer to as evaluations. 5 While an AVP may not be used if an appraisal is required, it is possible that some AVPs may be used in certain circumstances when an evaluation is required. Additional guidance from the Appraisal Standards Board (ASB) on this topic may be found in Advisory Opinion 13 (AO-13), Performing Evaluations of Real Property Collateral to Conform with USPAP. 6

109 Draft White Paper Alternative Valuation Products and the Uniform Standards of Professional Appraisal Practice AVPs are commonly requested by lenders (for transactions that do not fall under Title XI of FIRREA), loan servicers, government-sponsored enterprises, hedge fund companies, and other entities in capital markets. In addition, AVPs are sometimes used by property owners, potential homebuyers, insurance companies, marketing agencies, as well as a number of others.

110 Draft White Paper Alternative Valuation Products and the Uniform Standards of Professional Appraisal Practice Why do clients order AVPs in lieu of appraisals? If clients are not legally required or otherwise obligated, why would they order an AVP instead of an appraisal? Although there may be a number of reasons, they can essentially be classified into these categories: to utilize different or additional analytics to value the collateral; to reduce the time necessary to obtain a valuation; and/or to reduce the cost associated with obtaining a valuation. One such example can be found in the default mortgage-servicing sector. Clients often require valuations for each asset several times a year. Many of these clients feel the opinion of value may not be as important as the data presented; as a result, the cost of acquiring appraisals on a property several times each year is considered cost prohibitive.

111 Draft White Paper Alternative Valuation Products and the Uniform

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